Analysts at Keefe, Bruyette & Woods (KBW) have suggested that rate growth in the current hardening market should continue for longer than in typical ‘three-year’ cycles seen in the past, despite the fact that increases have generally been less abrupt this time around.
The firm believes that rate increases will be longer-lasting due to market participants’ recognition that rising loss costs, persistently pressured investment returns, and increasing volatility would otherwise likely produce returns ranging from inadequate to terrible.
Currently, KBW expects reinsurance rate increases to rise by 2-3% during the January 1, 2022 reinsurance renewals, reflecting abundant capacity that is rationally insisting on being paid more to assume risks that are themselves intensifying.
However, pricing will largely vary significantly by line and region, in an appropriate response to the particular challenges to adequate returns, it added.
“We don’t expect the pricing pendulum to swing as far as it has in past hard markets that were driven by capacity shortages, which in turn means that (re)insurers need the industry’s price discipline to persist for longer than during past hard markets, so that full-cycle expected returns are adequate even without a few ‘blowout’ years offsetting softer-priced accident years’ weaker returns,” KBW explained. “We won’t know whether this will happen for several years, but we’re cautiously optimistic that it will.”
An important point in KBW’s reasoning is the resilience and growing sophistication of ILS investors, which together imply that even huge catastrophe losses would probably not drive a capacity shortfall.
This would be the case even in a loss year that exceeded the considerable costs that the reinsurance has already racked up in 2021, which include Winter Storm Uri, the European floods in July, Hurricane Ida, west coast wildfires and significant hailstorms.
In fact, most of the executives consulted by KBW agreed that it would take a casualty shock to create that level of insufficient capacity.
“Limited ILS participation beyond short-tailed lines implies that lost capital supporting casualty lines wouldn’t be rapidly replaced, but inflecting loss trends for long-tailed lines take longer to identify (and management teams have more discretion over acknowledging their impacts), so we expect incremental – rather than abrupt – expected return improvement,” analysts concluded.